The digital business of structured products: Today and in future
By Daniel Hernandez
September 26, 2018
5 min read
Over the last few years, the structured products world has seen how technology and digitalisation have gone from being typical buzzwords used by consultants in every 2020 business plan to an actual reality that has impacted our industry directly in many different ways. Both issuers and distributors of structured products have embarked on technology projects either to satisfy recent regulatory requirements, to increase operational efficiency, or to enhance the service level they offer to their customers like never before.
However, this wave to digitalise the structured products business has also meant that a number of new players – fintechs, technology providers, platforms, etc. – have had the vision to identify gaps in the business that needed filling and successfully emerged to become key partners and play an important role in many of the steps of the distribution and management of structured products.
In light of this month’s main topic – ‘The future of finance’ – we caught up with a number of these structured products platforms and technology providers to get their views on both the current state of the digital business of structured products and the future of our industry (please refer to pages 26 and 27 for further information).
Read more in attachment Think Ahead
The digital business of structured products in the future
‘Digitisation has served as the lifeline for structured products business’, says Mahesh Bulchandani, Director and CEO Europe at FinIQ, when explaining how an industry that has faced increased pressure from regulators over the last decade and had fallen out of favour from some investors due to the financial crisis had managed to survive and grow exponentially over the last few years.
However, digitalisation entails not only IT investment but also a new mindset and new players. On the one hand, it is true that both increased investment in technology and innovation have accelerated the automation of the creation and processing of structured products, introducing new opportunities for market participants and ultimately changing market structure. Nevertheless, on the other hand, banks no longer possess a monopoly when it comes to bringing innovation into the market, as distributors and end clients now benefit from a new set of market participants who also contribute to shaping the infrastructure and digital landscape in which structured products operate.
If there is one thing that all these new players have in common, it is that they were able to identify, a number of years ago, key structural gaps in the structured products industry, and that they have all invested heavily, succeeding in digitalising different parts of the structured products business over the last few years. Consequently, given their proven success, we were most interested to hear their thoughts on what gaps they believed were still to be filled and to understand what overall they thought was the future for the digital business of structured products.
It is no surprise to hear that they all still believe that the future is digital. ‘It’s 100% the future, just like virtually every other business, the move from 0 to 100% into digital is just a matter of time,’ says Steve Price, CTO at Privatam, a view that is in line with the vision shared by Sean Morgan, Global Head of Sales at OTCX who expects: ‘The structured product world to become digitalised in many areas like the equities and futures market did in the late 90s/early 2000s.’
Biju Kulathakal, CEO and co-founder of Halo Investing, links the future development of the digital business of structured products to the innovations and developments that all these digital platforms are bringing onto the market: ‘As these platforms grow in scope and depth, innovations in access, understanding, transparency and post-trade management will allow more investors to use structured products.’ Already we see some banks and platforms automate price discovery to help end users make faster decisions and integrate risk management, overall facilitating the increased liquidity in the digital business of structured products. Milind Kulkarni, Global CEO at FinIQ, provides a similar insight and expects this to continue being a driver to both banks and platforms who have to continue innovating every year: ‘As more and more clients participate in the structured products segment for their investment or trading objectives, this problem is only going to make things difficult for banks. Hiring quotation-making staff is not sustainable. Given this background, the digital platforms will have to become smarter with each passing year.’
In any case, it is clear that digitalisation and increased investment in the technology of structured products will bring opportunities to the overall business. On the sell side, as costs are lowered and better service is provided to more and more clients, for instance, as Asaf Seri, President and COO of Modelity Technologies explains, ‘by automating all different steps in the life cycle of structured products, we are not just lowering the costs and increase efficiency for the market players, but we also contribute to the expansion of a number of end clients who can purchase structured products’. But, equally importantly, as Werner Kunz, Senior Product Manager of Avaloq highlights, ‘the next wave of digitalisation must happen at the buy side’, as distributors and end customers become more and more digital and start to realise that they also need to consider what areas of the value chain they are responsible for digitalising.
Per Nordstrom, Head of Sales at Contineo, predicts that the digital business will stop being a private banking topic but will also start playing a prominent role in the more institutional segments of our industry: ‘I foresee not only private banking customers but also institutional customers to be active and trade customised and non-customised structured products on a digital platform in the future’. This is a view shared by Nicolas Gaumont, co-founder and Managing Director at RiverRock Technology Solutions Limited, who expects that even ‘retail clients will have access to tools to create and execute their own bespoke structured product for as little as EUR 1,000 with the issuer of their choice’.
Finally, regulation is an additional factor that Karim Faraj, Global Head of Front Office Derivatives at Bloomberg, also believes will play an important factor in shaping the digital business of structured products, as ‘regulation will continue to drive digitalisation of structured products to help manage the costs of compliance, as well as increase the incentive for manufacturers and distributors to collaborate and offer liquidity. We may also see standardisation of products to a point where clients can get secondary prices from multiple dealers’.
Digitalisation along the structured products value chain
Then, where is digitalisation most effective? The value chain for structured products – all the way from pricing and product discovery to post-trade settlement and life cycle management – provides a large number of different operational steps that are perfect candidates for automation and digitalisation. Although, as Nicolas Gaumont from RiverRock states: ‘Digitalisation brings value at every stage of the transactional chain’, traditionally, price discovery and other pre-trade tasks have been the main areas where issuers and distributors have focused their investment in digitalisation, leading to the emergence of pricing and structuring platforms that facilitated the journey towards the execution of the transaction. Biju Kulathakal from Halo also highlights this aspect: ‘On the sell side, automated processes that drive down the cost of issuance result in lower notional minimums – in turn driving more sales and potentially lowering fees.’
But it feels as if this trend is starting to change. Martin Weibeler, Senior Product Manager at Primegate, believes that ‘within a very short perspective there will be a change coming that the end-to-end automatisation or the post-trade services will become more important than pricing itself’. Mahesh Bulchandani from FinIQ believes that, although price discovery and order execution have been the two crucial pillars of digitisation so far, ‘for established players the focus has shifted to pre-trade checks, documentation and independent monitoring of post- trade events’. This view is also shared by Contineo’s Per Nordstrom: ‘Life cycle management (i.e. post-trade information) is critical for ensuring investors have transparency in the performance of their structured products, and we foresee the full automation of this process across issuers.’
However, the investment in innovation across the value chain is not always driven by customer demand, as regulation is also a driver for innovation as Asaf Seri from Modelity highlights: ‘We are now in the age of regulation, and we see how the market participants are struggling under the burden of regulation.’ Pre-trade checks, post-trade reporting, specialised documentation and compliance are also main areas that require automation and digitalisation in order to scale any digital offering across a whole network.
Unfortunately, this is easier said than done. ‘We are aiming at more standardisation in post-trade processing by using standard APIs and message protocols for both the actual trade and life cycle events’, is the response given by Werner Kunz from Avaloq, when asked why the value chain is not fully digitalised already. Not only do we find major geographical, product or client requirement differences across the digital structured products business, but the lack of standardisation across the main players creates issues and concerns to most technology providers, and, as Bloomberg’s Karim Faraj highlights, the lack of standardisation across the industry is one of the main issues that needs to be addressed in order to be widely beneficial to the industry: ’Benefits from digitalisation will be seen along the whole value chain, especially if the industry comes together and standardises the nomenclature of products and events that occur throughout the life cycle.’
An effective distributor digital offering: The key ingredients
Whereas everyone in our survey is clear that digitalisation is the future and that it is important to pay attention to digitalising the post-trade element of the structured product’s life cycle, the different platforms we have spoken to share rather different views with regard to what constitute the key ingredients for an effective digital offering.
Product origination, price discovery and execution are, according to Steve Price (Privatam), the three key ingredients to have an effective digital offering, a view that is very much in line with OTCX’s Sean Morgan who highlights that ‘enabling pricing and execution to be more efficient opens up increased volumes in under-serviced customers who today aren’t able to access a full range of products’. This seems to be true for European distributors, where the digitalisation of structured products is still a few years behind in comparison to their Asian peers, where most private banks and other structured products players already use actively different digital price discovery and execution venues – some days sending more than 10,000 pricing requests – as platforms have worked with them to automate the increasing demand for that has been seen over the last few years. For instance, FinIQ’s Mahesh Bulchandani’s key ingredients for an effective distributor digital offering don’t focus on technical capabilities, but instead on a platform’s ability to integrate with other applications of the distributors to support decentralisation of duties or a platform’s proven record to work on mobile devices.
Martin Weibeler of Primegate similarly doesn’t include pre- trade elements amongst the key ingredients for a distributor’s effective digital offering, but instead focuses on more technical matters such as standardising buy side/sell side APIs or ensuring acceptable speed, as well as catering for the different regulatory requirements of each business. Bloomberg’s Karim Faraj also comments on the need to have well- defined schemas and APIs, along with being generic enough to handle all asset classes, products and workflow components seamlessly and consistently in order to ‘facilitate the quick addition of new offerings that can localise the product for each market segment and country’.
A different angle is covered by Per Nordstrom from Contineo, whose views on the key ingredients focus on the users: ‘I think the key ingredient is user adoption. Relationship managers and dealers are still accustomed to legacy workflows such as voice trading which is less efficient and leads to errors.’ While Asaf Seri from Modelity believes that digitalisation can ultimately help increase knowledge and ‘through technology you can provide your clients a better knowledge base and education’.
The role of artificial intelligence in structured products
Artificial intelligence (AI; along with distributed ledgers) has been an area which many have expected to play a key role as ‘the next disruptor’ in the structured products industry as in other asset classes, such as cash equities or forex (FX), where AI is already used to automate decisions or enhance execution, suggesting trades that offset risk and increase internalisation.
Some players, for example Bloomberg, already actively use AI as part of their data processing and ‘continually process an enormous universe of unstructured information across the world to break news that has the potential to move markets’ but, as Bloomberg’s Karim Faraj explains: ‘AI can also be used to customise offerings targeted to client investment profiles (asset classes, underlying, currencies, product types, risk appetite, target returns, etc.), as well as help with relative value trading and the timing to enter trades.’
This is especially true of the structured products domain, given the number of permutations possible, as Milind Kulkarni from FinIQ suggests: ‘AI can easily assist in shortlisting what products are relevant for a given client situation.’ This view is also shared by Biju Kulathakal from Halo Investing, who believes in the application of AI ‘to explain product suitability and provide recommendations for different products’; or Nicolas Gaumont from RiverRock, who also believes that AI will help to check and match each and every client’s risk profile, as distributors are now forced to design an exponentially growing number of bespoke solutions ‘which is not scalable without the help of technology, and this is where we believe AI could play an important role’.
A different angle is provided by Per Nordstrom from Contineo, who considers AI to still be in its infancy with robo-advisors and other wealth management tools not yet at the development stage nor ready for consumer adoption, and he actually finds the best case for its use to be in cybersecurity for financial institutions: ‘We have found that using AI allows the firm to detect fraud faster and highlight potential risk areas.’
What is the future for the structured products specialist?
If everything is to go digital, if the whole value chain is going to be automated and if robots and artificial intelligence are to create the best products and obtain the best prices, what role will structured product specialists and/or relationship managers play in the future?
Well, although the roles will change, hardly anyone believes that the machines will take over the world for now. ‘The human element will always be important to the process,’ explains Sean Morgan from OTCX, as he believes that the requirement for a client-facing role will always exist. Technology and digitalisation will help all users, including product specialists, aiding them in determining suitable products, which will provide an increasingly meaningful service to the customers.
‘There will be a mindset change,’ states Martin Weibeler from Primegate. Digital platforms will allow relationship managers to take a more active role in the request-for-quote (RFQ) process and, potentially, structured product specialists will now have to sell the platform instead of selling the product as the client or the relationship manager will be able to structure the product on their own.
But this change is not necessarily considered a threat. On the contrary: this can be seen as an opportunity to increase the quality of product and service. As Halo’s Biju Kulathakal highlights: ‘Across the market we have seen the ways in which relationship managers have leveraged technology to deliver better advice and investment solutions to their clients.’ This view is in line with Bloomberg’s Karim Faraj, who believes that ‘in a more automated environment, client relationship managers and product specialists can focus their time on high-touch service and on educating clients about structured products. Attracting new investors will help build new business and grow the total market’.
So, why is the structured products business still not fully digitalised across the board? Well, although based on our peers’ feedback, it would seem more a question of when rather than why, the reality is that digitalisation requires a level of investment and a degree of standardisation that goes directly against the benefit that a structured product brings to the world of finance, namely flexibility with reduced costs, or ‘the variety and personalisation it provides to the individual’, as described by Asaf Seri from Modelity. In addition, digitalisation is not so easily transportable into the heterogeneous and traditionally varied distribution networks that today use structured products as an important vehicle within their investment mix.
On the other hand, although it is not likely that our industry will be completely digitalised, the benefits that digitalisation have already brought to the first networks who have adopted digital structured products – i.e. increased business volumes whilst reducing the costs of issuance, increased transparency and service levels, etc. – along with the efforts and innovations that all these new fintechs, platforms and technology providers have brought to our industry, have shown the way and paved the future for others willing to consider migrating parts of their traditional businesses to a digital structured products franchise.
In any case, we are pleased that the demand for delivery of structured products via digital channels has been growing over the last few years, and it now represents a substantial part of our current global business within the EMC division of Commerzbank, particularly as we are able to provide customers with full front-to-back, straight-through processing (STP) of investment products via different channels:
- Via third-party platforms: Commerzbank is already working with a number of the most important third-party investment product venues that provide customers with price discovery and execution services
- Via direct connectivity: Commerzbank communicates directly with the customer’s IT infrastructures, either via FIX connections or using our state-of-the-art email connectivity interfaces
- Via the exchanges: Commerzbank can facilitate the price discovery and issuance of investment products within the most important exchanges for those customers who prefer to transact on these venues
If you would like to find out more on our capabilities and solutions on e-connectivity, please approach our Electronic Sales Trading team on emcelectronicsalestrading@ commerzbank.com.